respect of which the installment is paid. As soon as the aggregate of the amounts received and excluded from gross income equals the aggregate premiums or consideration paid for such annuity, the entire amount received thereafter in each taxable year must be included in gross income. The provisions of this section may be illustrated by the following examples: Example (1). A bought in 1935, for $50,000 consideration, a life annuity, payable in annual installments of $5,000. For the calendar year 1938 he would be required to include in gross income $1,500 of the $5,000 received during that year (3 percent of $50,000), $3,500 being exempt. If A should live long enough to receive as exempt $50,000, then all amounts he receives thereafter under the annuity contract would be included in gross income. Example (2). A bought an annuity on October 1, 1938, paying $100,000 as consideration therefor. The annuity amounts to $7,824 a year, payable in semiannual installments of $3,912, and on December 1, 1938, A received $1,304, the first payment under the contract being for a 2-month period. A shall include in his gross income for the calendar year 1938 the sum of $500, being 3 percent of $100,000 (the consideration paid) divided by 12 and multiplied by 2 (the number of months in respect of which the installment was paid). (3) Gifts, bequests, and devises.-The devise, or inheritance (but the income from value of property acquired by gift, bequest, such property shall be included in gross income); § 9.22 (b) (3)-1 Gifts and bequests. Property received as a gift, or received under a will or under statutes of descent and distribution, is exempt from the income tax, although the income therefrom derived from investment, sale, or otherwise is not. An amount of principal paid under a marriage settlement is a gift. Neither alimony nor an allowance based on a separation agreement is taxable income. (See § 9.24-1.) *† [SEC. 22. Gross income.] [(b) Exclusions from gross income.-The following items shall not be included in gross income and shall be exempt from taxation under this title:] (4) Tax-free interest.-Interest upon (A) the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia; or (B) obligations of a corporation organized under Act of Congress, if such corporation is an instrumentality of the United States; or (C) the obligations of the United States or its possessions. Every person owning any of the obligations enumerated in clause (A), (B), or (C) shall, in the return required by this title, submit a statement showing the number and amount of such obligations owned by him and the income received therefrom, in such form and may require. In the case of obligations of the United States issued after September 1, 1917 (other than postal savings certificates of deposit) and in the case of obligations of a corporation organized under Act of Congress, the interest shall be exempt only if Acts and to the extent provided in the respective authorizing the issue thereof as amended and supplemented, and shall be excluded from gross income only if and to taxes imposed by this title; the extent it is wholly exempt from the with such information as the Commissioner § 9.22 (b) (4)-1 Interest upon State obligations. Interest upon the obligations of a State, Territory, or any politi Example (3). A bought an increasing annuity on August 1, 1938, paying $40,000 as consideration therefor. The annuity amounts to $1,000 a year for the first year, $2,000 a year for the second year, and $3,000 a year thereafter, payable in quarterly installments. A received the first quarterly installment on November 1, 1938, amounting to $250. A shall in-cal subdivision thereof, or the District of clude in his gross income for the calendar year 1938 the sum of $250, being such portion of the installment as is not in excess of 3 percent of $40,000 (the consideration paid) divided by 12 and multiplied by 3 (the number of months in respect of which the installment was paid.** Columbia is exempt from the income tax. Obligations issued by or on behalf of the State or Territory or a duly organized political subdivision acting by constituted authorities empowered to issue such obligations, are the obligations of a State or Territory or a political subdivision thereof. Special tax bills issued for special benefits to property, if such tax bills [SEC. 22. Gross income.] are legally collectible only from owners [(b) Exclusions from gross income. The of the property benefited, are not the obfollowing items shall not be included in gross income and shall be exempt from tax-ligations of a State, Territory, or political subdivision. The term "political subdi ation under this title:] vision," within the meaning of the exemption, denotes any division of the State or Territory which is a municipal corporation, or to which has been delegated the right to exercise part of the sovereign power of the State or Territory. As thus defined, a political subdivision of a State or Territory may or may not, for the purpose of exemption, in clude special assessment districts so created, such as road, water, sewer, gas, light, reclamation, drainage, irrigation, levee, school, harbor, port improvement, and similar districts and divisions of a State or Territory.*† § 9.22 (b) (4)-2 Dividends and interest from Federal land banks, Federal intermediate credit banks, national farm-loan associations, banks for cooperatives, and production credit corporations and associations. Section 26 of the Federal Farm Loan Act of July 17, 1916 (39 Stat. 360), as amended by an Act approved March 4, 1923 (42 Stat. 1454), provides that Federal land banks, Federal intermediate credit banks, and national farm-loan associations, including the capital and reserve or surplus therein and the income derived therefrom, shall be exempt from taxation, except taxes upon real estate, and that first mortgages executed to Federal land banks, Federal intermediate credit banks, or to joint stock land banks, and farm-loan bonds, and debentures issued by intermediate credit banks, with the income therefrom, shall be exempt from taxation. Accordingly, the income derived from dividends on stock of Federal land banks, Federal intermediate credit banks, and national farm-loan associations and from interest on promissory notes secured by such first mortgages, or from such farm-loan bonds or debentures, is not subject to the income tax. However, dividends on the stock of the central bank for cooperatives, the production credit corporations, production credit associations, and banks for cooperatives, organized under the provisions of the Farm Credit Act of 1933, constitute income to the recipients, subject to both normal tax and surtax. Dividends on share accounts of Federal savings and loan associations are exempt from the normal tax under the provisions of section 5 (h) of the Home Owners' Loan Act of 1933 (48 Stat. 133).*† § 9.22 (b) (4)-3 Dividends from Federal reserve banks. Section 7 of the Federal Reserve Act of December 23, 1913, provides that Federal reserve banks, including the capital stock and surplus therein and the income derived therefrom, shall be exempt from taxation, except taxes upon real estate. This exemption attaches to and follows the income derived from dividends on stock of Federal reserve banks in the hands dends received on the stock of Federal of the shareholders, so that the divi reserve banks are not subject to the income tax. Dividends paid by member banks, however, are treated like dividends of ordinary corporations.*+ § 9.22 (b) (4)-4 Interest upon United States obligations. Although interest upon the obligations of the United States and its possessions and upon obligaAct of Congress, if such corporation is an tions of a corporation organized under instrumentality of the United States, is generally exempt from tax, in the case of obligations issued by the United States after September 1, 1917, which include Treasury certificates of indebtedness, Treasury bonds, and Treasury notes, and in the case of obligations of a corporation organized under Act of Congress, the interest is exempt from tax only if and to the extent provided in the Acts authorizing the issue thereof as amended and supplemented. Every person owning any of the obligations enumerated in clause (A), (B), or (C) of paragraph (4) of subsection 22 (b) shall submit in his income tax return a statement showing the number and amount of such obligations owned and the income received therefrom. For the purpose of such statement, in the case of Treasury bills issued after June 17, 1930, (1) the "amount of such obligations" is their par (maturity) value and (2) the "income received therefrom" is the net excess of the amount realized during the taxable year from the sale or other disposition of the bills over the cost or other basis thereof, a separate computation of discount being unnecessary. The interest on Treasury certificates of indebtedness is entirely exempt from Federal income taxes. Interest upon Treasury notes is exempt only to the ex- | 3, 1919, amending section 3 of the Fourth tent provided in the terms of the issue. Liberty Bond Act of July 9, 1918, the inInterest (discount at which issued) on terest received on and after March 3, Treasury bills and any gain from the 1919, on bonds, notes, and certificates of sale or other disposition of such bills are indebtedness of the United States while also entirely exempt from Federal in- beneficially owned by a nonresident alien come taxes. With respect to the non-individual, or a foreign corporation, partdeductibility of losses from the sale or other disposition of such bills, see § 9.23 (e)-1. The interest on Treasury bonds is exempt from Federal income taxes except surtaxes imposed upon the income or profits of individuals, partnerships, associations, or corporations. Treasury bonds are entitled to a limited exemption from surtaxes imposed by the United States. Interest on an aggregate of not exceeding $5,000 principal amount of these obligations is exempt from the surtaxes imposed by the Act. Interest in excess of the interest on an aggregate of not exceeding $5,000 principal amount of such obligations is subject to surtax and must be included in gross income. Interest credited to postal savings accounts upon moneys deposited in postal savings banks is wholly exempt from income tax.*† § 9.22 (b) (4)-5 Treasury bond exemption in the case of trusts or partnerships. (a) When the income of a trust is taxable to beneficiaries, as in the case of a trust the income of which is to be distributed to the beneficiaries currently, each beneficiary is entitled to exemption as if he owned directly a proportionate part of the Treasury bonds held in trust. When, on the other hand, income is taxable to the trustee, as in the case of a trust the income of which is accumulated for the benefit of unborn or unascertained persons, the trust, as the owner of the bonds held in trust, is entitled to the exemption on account of such ownership. (b) As the income of a partnership is taxable to the individual partners, each partner is entitled to exemption as if he owned directly a proportionate part of the bonds held by the partnership.*† nership, or association, not engaged in business in the United States, is exempt from income taxes.*+ SECTIONS 215 (a) AND (C) OF THE REVENUE ACT OF 1939 SEC. 215. DISCHARGE OF INDEBTEDNESS. (a) INCOME FROM DISCHARGE OF INDEBTEDNESS. Section 22 (b) of the Internal Revenue Code (relating to exclusions from gross income) is amended by adding at the end thereof the following new paragraph: (9) INCOME FROM DISCHARGE OF INDEBTEDIn the case NESS. of a corporation, the tributable to the discharge, within the taxamount of any income of the taxpayer atable year, of any indebtedness of the taxpayer or for which the taxpayer is liable evidenced by a security (as hereinafter in this paragraph defined) if— the Commissioner, or (A) it is established to the satisfaction of (B) it is certified to the Commissioner by any Federal agency authorized to make loans on behalf of the United States to such corporation or by any Federal agency authorized to exercise regulatory power over such corporation, that at the time of such discharge the taxpayer was in an unsound financial condition, and if the taxpayer makes and files at the time of filing the return, in such manner as the Commissioner, with the approval of the Secretary, by regulations prescribes, its consent to the regulations prescribed under section 113 (b) (3) then in effect. In such case the amount of any income of the taxpayer attributable to any unamortized premium (computed as of the first day of the taxable year in which such discharge occurred) with respect to such indebtedness shall not be included in gross income and the amount of the deduction attributable to any unamortized discount (computed as of the first day of the taxable year in which such discharge occurred) with respect to such indebtedness shall not be allowed as a deduction. As used in this paragraph the term "security" means any bond, debenture, note, or certificate, or other evidence of indebtedness, issued by any corporation, in existence on June 1, 1939. This paragraph shall not apply to any discharge occurring before the date of the enactment of the Revenue Act of 1939, or in a taxable year beginning after December 31, 1942. (c) TAXABLE YEARS TO WHICH APPLICABLE The amendments made by this section shall be applicable to taxable years beginning after December 31, 1938. § 9.22 (b) (4)-6 Interest upon United States obligations in the case of nonresident aliens and certain foreign organizations. By virtue of section 4 of the Victory Liberty Loan Act of March | charge of indebtedness. Section 22 (b) § 9.22 (b) (9)-1 Income from dis tion. Thus, for example, if a corporation obtains a discharge of its indebtedness represented only by open account book entries, section 22 (b) (9) and this section are inapplicable. If, however, a cor (9) provides a method whereby a corpo- | payer corporation or any other corporaration may elect to have excluded from its gross income the amount of income attributable to a discharge, within the taxable year, of its indebtedness or of indebtedness for which it is liable as, for example, in the case of a debt arisingporation obtains a discharge of its liabilfrom an assumption of liability of another corporation. To be entitled to the benefits of the provisions of section 22 (b) (9) a corporation must (1) file with its return for the taxable year a consent to the provisions of the regulations, in effect at the time of the filing of the return, prescribed under section 113 (b) (3) (see §§ 9.113 (b) (3)-1 and 9.113 (b) (3)-2, relating to adjustment of basis), and (2) establish that it was in an unsound financial condition immediately preceding the discharge of the indebtedness. The existence of an unsound financial condition, for the purposes of section 22 (b) (9), may be established (1) by satisfying the Commissioner of such condition upon a presentation to him of all facts pertinent to the financial condition of the corporation or (2) by having presented to the Commissioner a certification of such condition by any Federal agency (e. g., the Reconstruction Finance Corporation) authorized to make loans to such taxpayer on behalf of the United States, or by any Federal agency (e. g., the Interstate Commerce Commission) authorized to exercise regulatory power over the taxpayer. Such a certification will be deemed to be conclusive upon the Commissioner. The certification should accompany the return. A corporation may be in an unsound financial condition, within the meaning of section 22 (b) (9) and this section, even though the fair market value of its assets exceeds its liabilities or it is able to meet its current liabilities as they mature. Thus, highly indicative (but not conclusive) of an unsound financial condition would be the fact that bonds of the taxpayer are selling in a free market at prices substantially below their issue price and below the market price of similar issues of similar businesses. As used in this section “indebtedness" means indebtedness evidenced by a bond, debenture, note, or certificate, or other evidence of indebtedness, in existence on June 1, 1939, and issued by either the tax ity (evidenced by its writing) arising from an assumption of a debt of an individual or a discharge of its liability (whether or not evidenced by a writing) arising from the assumption of the indebtedness of another corporation, section 22 (b) (9) and this section are applicable. If as a result of the discharge of indebtedness there remains unamortized premium or unamortized discount, the amount of the income attributable to such premium is to be excluded from gross income and the amount of the deduction attributable to such discount shall be disallowed as a deduction. The unamortized premium and unamortized discount, as the case may be, is in each instance to be computed as of the first day of the taxable year in which the discharge of indebtedness occurred. The provisions of section 22 (b) (9) and this section are inapplicable in the case of any discharge occurring-(1) in a taxable year beginning before January 1, 1939; (2) before June 29, 1939; (3) in a taxable year beginning after December 31, 1942; or (4) in any proceeding under section 77B of the Bankruptcy Act of 1898, as amended, or under Chapter X, XI, or XV of such Act. (I.R.C. 62, 53 Stat. 32; 26 U.S.C., Sup., 62) [Art. 22 (b) (9)-1, Regs. 101, as added by T.D. 4954, Nov. 16, 1939; 4 F.R. 4625] § 9.22 (b) (9)-2 Making and filing of consent. A consent to have the basis of its property adjusted in accordance with the provisions of the regulations, in effect at the time of filing of the return, prescribed under section 113 (b) (3) (see §§ 9.113 (b) (3)-1 and 9.113 (b) (3)-2) shall be made by or on behalf of the taxpayer corporation in duplicate on Form 982, in accordance with the regulations in this part and the instructions on the form or issued therewith. The original and duplicate shall be filed with the return. (I.R.C. 62, 53 Stat. 32; 26 U.S.C., Sup., 62) [Art. 22 (b) (9)-2, Regs. 101, as added by T.D. 4954, Nov. 16, 1939; 4 F.R. 46261 [SEC. 22. Gross income.] [(b) Exclusions from gross income. The following items shall not be included in gross income and shall be exempt from taxation under this title:] should include in inventory merchandise purchased, title to which has passed to him, although such merchandise is in transit or for other reasons has not been (5) Compensation for injuries or sick-reduced to ness.-Amounts received, through accident or health insurance or under workmen's com pensation acts, as compensation for personal injuries or sickness, plus the amount of any damages received whether by suit or agreement on account of such injuries or sickness; (6) Ministers.-The rental value of a dwelling house and appurtenances thereof furnished to a minister of the gospel as part of his compensation; (7) Income exempt under treaty.-Income of any kind, to the extent required by any treaty obligation of the United States; (8) Miscellaneous items.-The following items, to the extent provided in section 116: Earned income from sources without the United States; Salaries of certain Territorial employees; The income of foreign governments; Income of States, municipalities, and other political subdivisions; physical possession, but should not include goods ordered for future delivery, transfer of title to which has not yet been effected. (But see § 9.22 (d)-1.) *† [As amended by T.D. 4959, Dec. 28, 1939; 4 F.R. 5001] end of this section was added by T.D. 4959, NOTE: The sentence in parentheses at the Dec. 28, 1939; 4 F.R. 5001. § 9.22 (c)-2 Valuation of inventories. Section 22 (c) provides two tests to which each inventory must conform: (1) It must conform as nearly as may be to the best accounting practice in the trade or business, and (2) It must clearly reflect the income. It follows, therefore, that inventory rules cannot be uniform but must give Receipts of shipowners' mutual protection effect to trade customs which come and indemnity associations; Dividends from China Trade Act corpora tions; within the scope of the best accounting practice in the particular trade or busi Compensation of employees of foreign gov-ness. In order clearly to reflect income, ernments. (c) Inventories.-Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with these regulations. An inventory that can be used under the best accounting practice in a balance sheet showing the financial position of the taxpayer can, as a general rule, be regarded as clearly reflecting his income. § 9.22 (c)-1 Need of inventories. In order to reflect the net income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, The bases of valuation most commonly purchase, or sale of merchandise is an used by business concerns and which income-producing factor. The inventory meet the requirements of section 22 (c) should include all finished or partly fin- are (a) cost and (b) cost or market, ished goods and, in the case of raw ma- whichever is lower. (For inventories by terials and supplies, only those which dealers in securities, see § 9.22 (c)-5.) have been acquired for sale or which will Any goods in an inventory which are physically become a part of merchan- unsalable at normal prices or unusable dise intended for sale. Merchandise in the normal way because of damage, should be included in the inventory only imperfections, shop wear, changes of if title thereto is vested in the taxpayer. | style, odd or broken lots, or other simiAccordingly, the seller should include in his inventory goods under contract for sale but not yet segregated and applied to the contract and goods out upon consignment, but should exclude from inventory goods sold, title to which has passed to the purchaser. A purchaser lar causes, including second-hand goods taken in exchange, should be valued at bona fide selling prices less direct cost of disposition, whether basis (a) or (b) is used, or if such goods consist of raw materials or partly finished goods held for use or consumption, they shall be |